There is No Middle Income Trap

Concerns about the so-called “middle-income trap” have recently emerged among many middle-income countries, particularly after the term was coined in 2007 by two World Bank economists. Worried that they may become “trapped” at the middle-income level, these countries are seeking a set of policies that can help them achieve strong and sustained growth and eventually help them join the league of high-income countries.

In our recent paper, we try to shed some light on both issues. First, we do not find that countries are trapped at middle income. “Escapees” – countries that escaped the middle-income trap and obtained a per capita income higher than 50% of the U.S. level – tend to grow fast and consistently to high income, and do not stagnate at any point as a middle-income trap theory would suggest. In contrast, “non-escapees” tend to have low growth at all levels of income. In other words, while the existence of a middle income trap implies that growth rates systematically slow down as countries reach middle-income status, no such systematic slowdown is apparent in the data. Second, we provide some descriptive and econometric evidence for a different set of “fundamentals” that enable middle-income countries to grow faster than their peers. We find that faster transformation to industry, low inflation, stronger exports, and reduced inequality are associated with stronger growth.

Not many countries graduated from middle income. Figure 1 shows countries’ long run changes of their income relative to the U.S. The log of per capita income relative to the U.S. in 1960 is on the x axis, with the 2009 value on the y axis. Each axis is divided into three areas, representing the three income groups. Low-income, middle-income, and high-income countries are those that have PPP GDP per capita less than or equal to 10%, between 10% and 50% and above 50% of U.S. PPP GDP per capita. Countries in the top-middle quadrant (in red) are those that “escaped” from middle income to high income over this period. The list of escapees includes Greece; Hong Kong SAR, China; Ireland; Japan; Puerto Rico; the Republic of Korea; Seychelles; Singapore; Spain; and Taiwan, China. Two countries that nearly make the list (the top of the middle quadrant) are Portugal and Cyprus, which are still classified as middle income in 2009.

We find little evidence of a middle income trap. Figure 2 shows the average annual growth rates at different per capita income levels relative to the U.S. (shown in the x-axis). The blue columns are the average growth rates for countries that ever escape from middle income to high income, and the orange columns represent growth rates for those countries that never escape. The escapees do consistently much better than their non-escapee counterparts, and they do not exhibit significant signs of slowing down. In contrast, non-escapees have low and stable growth over all levels of income: they too do not show signs of slowing down at middle income. Others, including those in this blog , similarly raise doubts about the existence of a middle-income trap.

Another graph reinforces the notion that countries do not slow down at middle income levels (relative to the U.S.). Figure 3 shows a scatter plot of countries’ subsequent 10 year average growth against (log of) countries’ initial income relative to the U.S. in 1960, 1970, 1980, 1990 and 2000. Evidence for a middle income trap would imply a U-shaped curve, with countries systematically slowing down at middle income levels. We do not see such evidence.

If one believes different sets of policies are needed at different stages of development, the above evidence suggests that “escapees” successfully change and adopt appropriate policies to consistently grow from low to middle to high income.

The question remains of what set policies are needed to lift countries from their middle income level. While we stay away from policy recommendation, we examine a series of “fundamentals” for middle-income countries that seem to be associated with higher growth. Our descriptive analysis shows the following are associated with high growth for middle-income countries (1) economic structure, namely a faster transformation from agriculture to industry; (2) export-orientation; (3) lower inflation and external debt; and (4) decreases in inequality and the age dependency ratio. Our cross-country econometric analysis also confirms that growth in middle-income countries is positively associated with industrialization, openness and equality. Interestingly, we do not see a clear role of education and innovation in both types of exercises.

If a golfer avoids all sand traps in the course of playing a round of golf, should we conclude that there are no sand traps, or that the presence of sand traps did not affect the play? Of course not, that would be absurd, but this is the logic presented above.

Are there middle-income countries who have failed to grow over long periods of time in the post world war 2 era? Surely yes. The fact that these countries are middle income suggests they did grow at some stage. These are countries that have succumbed to a middle income trap.

Cross-country regression analysis may not be the best tool for examining these kinds of issues.

Our argument is not that countries cannot become trapped at middle income, but simply that traps at middle income levels are no more likely than traps at other income levels: income levels are very persistent. To continue the golf analogy, think of economic development as one long hole on a golf course. A player (country) starts at the zero income tee box and attempts to reach the high income green. The “middle income trap” idea implies that a massive sand trap lies halfway down the fairway that most players hit into and can’t hit out of. Alternatively, we argue that sand traps litter the entire fairway: there are potential traps at low income, low-middle income, middle income, upper-middle income, etc. A golfer who can identify which clubs (policies) to use at any point along the course (given many factors in addition to trap placement: course geography, climate, skill level, club quality, etc.) can avoid these traps and reach the green.

I like this debate - it's healthy and interesting. In Africa however an arguably more relevant question is what set policies are needed to lift countries TO (rather than from) middle income levels - or from lower middle income to higher middle income. Ghana (where I am currently located) is aan example of a country that seems to think it can get away with not nicely following the proven development curve - there are no signs of a labor-intensive light manufacturing industry developing, agriculture's performance is a roller coaster, and prices of vital export minerals (oil, gold) are down. There is no substitute for a series of governments that consist of able, well-trained technocrats that are able to put the right policies and public investments in place to get these type of countries going - just like SE Asia did 50 years ago. Or am I dreaming?

Hans, thanks for your comment. It is true that getting from low income to middle income is as hard, if not harder, than from middle income to high income (see for example Figure 1 in our blog). Development policies are not easy at any stage of development.